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Graham Birch, from Merrill Lynch

«The China Factor came to stay»

China emergence and the geo-political instability are "feeding" a positive momentum for metal and mineral commodities. Particularly gold is in a buoyant market - the 500 dollars/oz can be reached end of 2005.

Jorge Nascimento Rodrigues interviews Graham Birch, November 2004

Website Natural Resources Funds

GRAHAM BIRCH, 44, is an English PhD in nickel geology at the Royal School of Mines that manages 7 billion dollars of Natural Resources Funds at Merrill Lynch Investment Managers, the independent asset management unit of Merrill Lynch. Some of the Funds he manages have posted outstanding recent performance, which has drawn the attention of private and institutional investors alike. The press call him the "Merrill's golden boy" - literally, because one of his specialities is managing gold. He is based in London where he heads the Natural Resources Team, with 5 fund managers and 2 graduate research assistants, including 4 geologists - a bunch of guys that can go to the mining field sometimes in far-flung places and evaluate with their eyes the quality of assets and "gossip" what's going on in the industry. "That's a huge advantage for our team", he confesses. They are not mere financial analysts behind their desks and desktops. They go around the world, even if necessary 2,5 kilometres down the earth or living for some weeks in basic cabins in remote places with unglamorous temperatures and environment. Their motto is simple: "By visiting the asset we can get information about a whole raft of companies and can get a sense of the geography, the region and the politics". "Sometimes we bring along very sophisticated institutional investors, like the Swiss", he said with a bit of irony. China is one of the main destinations nowadays - Graham just organized two major visits this year. Other destination is the Russian republics. Or Canada or India. "We travelled a lot in the last 6 months, because of all this growth in the commodities' markets and the growing interest from investors that it was not use", explains Birch. His secrets: total alert for discoveries in the world mining, globetrotting the field, good assessment of political risk, not-ideologically biased, also never take the short-term view. He mixes knowledge about geology with ten years of stockbroker specialist in the City.

  • Mining sector enjoying record earnings growth
  • Gold price in solid trading up trend above 400 dollars/oz
  • Commodities likely to remain in deficit during 2005
  • High oil and gas prices set to continue
  • Increased earnings from those companies most leveraged to the oil price
  • China Factor is one of the new structural constraints
  • Decline of cost of power generation based in new energy sources
  • Investor sentiment on the turn from negative to positive regarding new energies
  • A first question, a little bit provocative. With the geopolitical instability and the "China factor" the market for commodities is booming since the stock market crashes of 2000 and the economic recession of 2000/2003 in the US and Europe. So, the global "disarray" in 2/3 of the world is good for your Natural Resources Funds?

    Well, yes. And if George Bush policy continues, we will have a weak dollar and an unstable world politics. Its foreign policy is quite aggressive, and I do not see why he will change. So, Bush is good news for gold, our most important area in our portfolio of Natural Resources Funds. The situation is quite clear: low interest rates, weaker dollar, continuing global political instability, continuing hedge buy-backs, increasing investment in gold as a refugee asset.

    You mentioned gold as your area of excellence in management of Funds. The GATA (Gold Anti Trust Action Committee) have been alerting the last years for the up trend in the gold price, from the lowers of 290 dollars per ounce in 1998-2002. Do you think we can expect a "jump" in the gold spot price from the present high of 436 dollars per ounce?

    May be it can reach the 500 dollars per ounce in one year time. The historical dynamics is 1 dollar higher per week in the last two years. So, by the end of 2004 we can have 450 dollars per ounce, and at end of 2005 probably 500. A lot will depend on the weakness of the dollar. And I think the dollar will stay low. But there's a good reason for investors be interested in gold for the long term. The structural thing is quite simple: We can't extract enough gold from the mines regarding the huge demand. The supply will not increase. Mine supply continues to decline with further cuts in South Africa this year. So the price will go higher.

    «But there's a good reason for investors be interested in gold for the long term. The structural thing is quite simple: We can't extract enough gold from the mines regarding the huge demand.»

    When you talk of a huge demand for gold, you mean the prospects for China? The China Factor is the crucial point?

    Yes, China has become the most important consumer of commodities - but not only in the industrial side. In the gold area we will see in the future the impact of growing consuming demand from Chinese -as it happened with India. Analysts forecast Chinese demand to rise threefold from 200 to 600 tones in the next few years. Gold supply from Chinese mines is aligned with the present demand. So, the growing gold Chinese demand will need to be imported. Not many people thought about this trend. Including the central banks in the West that sold the gold reserves in a period of lower prices.

    So, the "China factor" is provoking a "revolution" in the mining world?

    Our view is long term. China will continue to grow quite strong, even if, in the near term, conditions can fluctuate. The China Factor has a long-term effect. It came to stay. Demand growth led by China continues to outpace supply growth. In our Fund, we have made large investments that will benefit from Chinese imports of commodities in the metals and mineral sectors.

    Oil is, probably, the "king" of commodities nowadays. Some analysts pointed out in the last years that the present incredibly hyped oil situation is "pressed" by two realities: geo-political instability and the expectation of the world peak of oil in the next years. What's your forecast regarding the price of the barrel?

    It's hard to know. It's a bit like the other commodities we talk, because of the China Factor. There is no flexibility in the supply side and the big oil companies have no flexibility also. We have a historically low level of spare capacity from OPEC and we witness supply disruptions more frequent. Oil majors also struggle to grow production. The price will not go down very much. Also as you know a lot of oil fields are mature and we saw project delays. So, our view is that you have to have a high price. I think the price will remain quite strong.

    So, there's a big opportunity for investors in those oil companies, and not only in the big ones?

    Absolutely. The share prices do not reflect yet the high price of the oil barrel. The shares reflect a price of 30 dollars a barrel. So, there's a gap, an opportunity for increase the share value. We are witnessing oil companies buying its own shares and we will see more takeovers in the area. Oil companies can't grow from exploration, so they have to do it by takeover.

    «Our view is that you have to have a high (oil) price. I think the price (of the barrel) will remain quite strong.»

    You see more consolidation in the big ones?

    No. Takeovers will target the mid-caps. I saw opportunities in Russia - despite its risks - and in the Canadian tar sand companies. Most of our portfolio is exactly on mid cap companies. In some cases the opportunities that these mid cap offer are superior to the larger ones.

    The perception of high political risk in the main areas of the oil geography (Caribbean, Africa, Middle East, Caspian Sea) plays a key role regarding the multinational and local oil companies. What are the guidelines for stock investors in this field?

    I think the oil Chinese companies will be interesting. Also interesting to follow the Chinese strategy. China is avoiding the US trend (its growing dependence in oil imports) and is developing strategic alliances in the oil area, with Brazil and Venezuela. And they are buying companies in the minefield. They do have the money; they can afford to buy strategic commodity assets. For instance, they just announced exclusive negotiations with Noranda Inc., in Canada. China Minmetals wants to acquire 100% of Noranda's outstanding common shares.

    Also recently China has signed an agreement to buy oil and gas from Iran and to develop Iran's Yadavaran oil field.

    China wants to guaranty strategic commodities.

    Natural Gas is the "challenger" of oil hegemony in this century?

    Gas is a different type of commodity - the markets are more regional. Demand is good, but there's not enough investment in gas. And there are not so much reserves of gas if you compare with coal for instance. But the prices will stay higher. We think we enter in a new era of higher gas prices driven by supply constraints. In our outlook, the US natural gas price will remain historically high, in a new price band.

    Some studies mention the re-emergence of nuclear power and forecast a boom for the uranium price. Currently it's traded at 20 dollars/lb, for August next year analysts' target is over 30 dollars/lb. What is your opinion?

    I think China can develop more nuclear power. But there's worldwide quite a lot opposition. And you know the cost of decommission is very high in the future. Uranium was in surplus, some years ago because of the decommissioning of the nuclear weapons, but now there's a shortage. So, the price is in an up trend.

    «I think alternative energy sources are competitive in current energy price environment.»

    Would you recommend a special attention from investors to companies in the uranium geography?

    South Africa was one of the uranium producers. In the gold mines you can extract uranium. With lower prices of uranium they stopped to extract uranium, but, now, with the high prices, some companies began to think of returning to exploration.

    One of the companies in the breaking news is a gold-uranium South African producer called Aflease that controls 60% of South Africa's easily available uranium. Its CEO is currently on an overseas road show visiting potential investors…

    Also in Canada, Cameco Corporation, a dominant nuclear energy company producing uranium fuel, can expand.

    Do you expect a real window of opportunity for "green" energies?

    I think one of the interesting facts is the declining cost of power generation from wind or geothermal or natural gas in recent years. These costs will approach in 2005 the cost in euros per MWh for nuclear or coal gasification or supercritical coal. Even from the solar energy, we are seeing a decline cost trend, even if its cost is higher than the others. But, how much renewables will be in the power mix that's the question. I think alternative energy sources are competitive in current energy price environment. But our New Energy Fund is not only about renewables. We include also new technologies on the cusp of being commercially viable - fuel cell technology used in cars and buses, super conductors used in transmission grid infrastructure, etc.. But that's a quite volatile area.

    Merrill Lynch Investment Managers Approach
  • Mining: positive on copper, nickel, aluminium and bulk commodities (iron ore, coking coal and thermal coal)
  • Gold: positive on gold companies with by-product credits
  • Energy: positive on exploration and production and oil services which are most leveraged to the higher oil price
  • New Energy: focus on technologies for blackout avoidance, emission reduction and energy efficiency
  • Geo-Economy: increasing emphasis on emerging markets - China Factor, Russia - and unglamorous places
  • ©, 2004

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